Neo Institutionalism vs New Institutional Economics

Neo Institutional theory is quite different from New Institutional Economics (NIE). NIE is also called “Transaction Cost Economics”. Transaction Cost Economics is interested in explaining governance forms from an economics perspective. It does not focus on the institutional field in which organizations are embedded.

What type of questions Neo Institutional theory attempts to address?

According to  William Richard Scott, Institutions and Organizations (1995) Neo Institutional theory can address such questions like:

• Why do organizations of the same type, such as schools and hospitals so closely resemble each other.
• Why is it that the behavior of organizational participants is often observed to depart from the formal rules and stated goals of the organizations.
• Why and how do laws, rules and other types of regulative and normative systems arise
• Why do specific structures and practices diffuse in ways not predicted by the particular characteristics of adopting organizations
• Why do organizations and individuals conform to institutions, is it because of rewards, moral obligations or because they cannot think of any other way of behaving?
• Or why if institutions promote stability, how does change occur?

Legitimacy

Meyer and Rowan observe that the assumption that organizations function according to their formal blueprint: coordination is routine, rules and procedures are followed and actual activities conform to the prescription of formal structure is challenged by empirical research on organizations. This research drives some questions like why is there decoupling between activities and formal organizations or why are evaluation system rendered vague or ignored?

To answer this question, Meyer and Rowan look at the institutional sources of formal structures and argue that scholars who have focused on the norm of rationality have overlooked another source of formal structures discussed by Max Weber – the concept of  legitimacy.

According to Suchman (1995), legitimacy can be defined as a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions. So Meyer and Rowan argue that rationalized structures are legitimate. In a complex network of interactions, rationalized myths (unverified stories) are necessary for actors to make decisions. They are beyond the discretion of an individual. Therefore they are taken for granted as legitimate, independent of evaluations of their impact on work outcomes.

Isomorphism

Isomorphism helps organizations to interact with their environment and enhance their chances of survival. Organizations adopt recognized formal structures and conform to external assessment criteria (e.g. accounting norms).

An highly institutional environment stabilizes both external and internal relationships. Organization that conform to institutional constraints are seen as legitimate and this enhance their survival chances and this occurs independently from efficiency criteria.

But how do organizations achieve efficiency in an highly institutional environment?

While organizations conform with established myths, organizations have to resolve the inconsistencies between these norms and the achievement of efficiency. Goals and norms are stated in vague term allowing coordination and mutual adjustment to be done informally, so the actual organization is “decoupled” from the formal organization.

The “Iron cage” is revisited through institutional theory

Powell and DiMaggio take Weber’s “iron cage”of rationality, driving the formation of organizational structure, and revisit it through the institutional theory, observing that organizational structure is not necessarily driven by efficiency. While Meyer and Rowan talked about the environment and networks of relations, Powell and DiMaggio use the concept of field for that, so they define it as “a recognised area of institutional life” which does not only comprise organizations that compete or interact but a more comprehensive set, a set of empirically defined “relevant actors”.

Three mechanisms of institutional isomorphic change operate at the organizational and field level:

• Coercive isomorphism results from internal and external pressures by actors such as the State.
• Mimetic isomorphism is associated with uncertainty. Mimetic behavior occurs when the environment is uncertain and solutions are unclear.
• Normative isomorphism is associated with professionalization. A category of professionals identically trained implements some norms across organizations.

Organizational predictors of isomorphism

In terms of the organizational predictors of isomorphism, it is possible to outline the following ones:

• The higher inter-organizational dependence (including centralization of resource), the greater the level of coercive isomorphism.
• The uncertainty between means and ends and ambiguity of goals fosters mimetic isomorphism.
• The more reliance on academic credentials in choosing personnel and participation in trade and professional organizations, the greater the level of normative isomorphism.

Field predictors of isomorphism

In terms of the field predictors of isomorphism, it is possible to outline the following ones:

• The dependence of the field on a single source of support and level of transaction with the state fosters coercive isomorphism.
• Technological uncertainty and limited number of alternative organizational models fosters mimetic isomorphism.
• Professionalisation and well established structures foster normative isomorphism.

Main variables in transaction cost economics

• Frequency: If a particular transaction occurs very infrequently in an organization, the cost of maintain the necessary resources in-house are too high.
• Uncertainty: If there is a high level of uncertainty, some events may occur that can hurt one of the two counter-party.
• Asset specificity: If the assets involved in a particular transaction are specific to the transaction, the two parties are linked.

Nevertheless, some of the limitations of the Transaction Cost Economics are:

• Behavioral Assumption on profit maximizing
• Differentiating between Transaction Cost and Production Cost is often difficult
• Reputation and Trust are not considered.
• Transactions are assumed to be independent.

With this brief overview it is possible to have a better understanding of the roots of the Transaction Cost Economics.